Will the royal commission's report trigger the worst housing downturn?

By Gerv Tacadena
1 Feb 2019

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Ahead of the release of the results from the Hayne royal commission, Endeavour Equity Strategy expects the tighter lending standards to cause prices to decline by 25% to 30% from their peaks — the worst downturn since 1890.

Endeavour Equity Strategy founder Douglas Orr previously predicted prices to fall only by 15% to 20%. However, following the revelation that the Household Expenditure Measure (HEM) used in in writing almost all mortgages between 2012 and 2016 has overstated homebuyers’ borrowing capacity, he said deeper price falls are likely as more homeowners find themselves in negative equity.

In a report by The Australian Financial Review, Orr said it is likely that there will be more loan defaults this year as lending screws are tightened.

"The size of the credit crunch is directly proportional to the unreasonableness of the HEM expenses benchmark. Since HEM expense estimates are very unreasonably low, the credit crunch will be significant and ongoing as it is increasingly replaced with reasonable expenses," he said.

Orr said the expenses of many households were understated using the model, significantly increasing their borrowing capacity. Borrowers who would have been given the green light to get a $1.15m loan using the model would now only be able to borrow $620,000.

"We expect the use of the HEM to be greatly reduced after the royal commission's findings are handed down. The HEM is much more unreasonable than commonly understood, and has led to significantly high portions of non-prime loans, 25 per cent higher than prime lending would have allowed," he said.

With this in mind, it is expected that last year’s credit crunch will persist as banks and lenders assess their clients on more realistic measures.

"Loans written in 2014 will experience significant losses with many in 2015, 2016, 2017 in negative equity," Orr said.

Given that many interest-only loans will switch to principal and interest, banks are also anticipated to record an increase in mortgage arrears.